Victrex (LON:VCT) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Victrex (LON:VCT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Victrex, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.14 = UK£71m ÷ (UK£559m - UK£40m) (Based on the trailing twelve months to March 2021).

So, Victrex has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 10% generated by the Chemicals industry.

Check out our latest analysis for Victrex

Above you can see how the current ROCE for Victrex compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Victrex here for free.

What Does the ROCE Trend For Victrex Tell Us?

When we looked at the ROCE trend at Victrex, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 26% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

What We Can Learn From Victrex's ROCE

We're a bit apprehensive about Victrex because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 97% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 1 warning sign with Victrex and understanding it should be part of your investment process.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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